Recent Developments in Joint Ventures - St. David’s Health Care System

St. David’s Health Care System v. U.S., 5th cir. No 02-50959, 11/7/03 – St. David’s Health Care System brought suit in Federal court arguing that it qualified as tax-exempt under §501(c)(3). The IRS ruled that St. David’s was not entitled to tax exemption because it had formed a partnership with a for-profit company and ceded control of its operations to the for-profit entity. Both sides filed motions for summary judgment at the district court. The district court granted St. David’s motion, ordered the government to refund the taxes as well as pay attorney’s fees and litigation costs. The government filed an appeal. The Fifth Circuit Court found that the district court erred in granting St. David’s motion for summary judgment as the case contained issues of material fact. The Court vacated the district court decision and remanded it for further proceedings.

In its ruling, the fifth circuit court concluded that St. David’s had not demonstrated it had sufficient control in the joint venture to operate exclusively for charitable purposes. Among the items cited was that even though St. David’s had contractual rights to take certain actions, the organization did not appear to have the effective ability and the willingness to enforce those rights (either by taking any action, suing, or terminating the agreement).

The control elements contained in the partnership and management services agreement included: (1) statement that the manager of the partnership “shall” operate the partnership facilities in a manner that complies with the community benefit standard; (2) ability of St. David’s to unilaterally remove the manager if it takes any action with a “material probability of adversely affecting” St. David’s tax-exempt status; (3) ability of St. David’s to appoint half of the partnership’s board of Governors; and (4) Power to appoint the initial CEO and unilaterally remove the CEO.

The ruling is an affirmation of the approach of Rev. Rul. 98-15 because it focuses on control as a key factor in determining whether participation in a joint venture furthers a charitable purpose. However, Rev. Rul 98-15 only provides clear guidance if the facts fit squarely under either of the two scenarios. Most organizations fall somewhere in the middle, and thus must make judgments based on imprecise guidance. After the district court’s decision, some assurance was provided that an evenly split governance board would not necessarily result in a loss of exemption for the nonprofit partner; but the appeals court decision significantly undermines that position.

Upon remand, a jury ruled in favor of St. David’s. It is not known if the government will appeal the decision; however, IRS officials have indicated that the appellate court holding is the one to use for guidance on structuring partnerships between tax-exempt organizations and for-profit corporations.

Recently, the IRS released Revenue Ruling 2004-51 which involves a LLC formed between a for-profit company and a not-for-profit organization to conduct interactive video training programs. While the LLC is owned 50-50 by each party, the not-for-profit organization had exclusive right to approve curriculum, training materials, and instructors, and determine the standards for successful completion of the training. The governing documents limit the activities of the for-profit partner. The IRS ruled that the LLC would not jeopardize the exempt status nor would it result in unrelated business income. The ruling does not offer much further insight into for-profit/not-for-profit joint ventures, but just continues in the same vein as Revenue Ruling 98-15 and the position of the IRS in Redlands and St. David’s.Form 990-T extension provisions

New Temporary Regulations section 1.6081-9T states that exempt organizations may automatically extend the time for filing "Form 990 (series)" returns for three months without a signature or explanation of why an extension is needed. An additional three month extension can be requested if the organization provides an explanation and signs the form. The statement in the regulations for an automatic three month extension included Form 990-T filers.

The new regulations are effective for returns due after June 11, 2003. Previously, Form 990-T filers could automatically receive a six-month extension of time. Form 8868, Application for Extension of Time to File an Exempt Organization Return, under which Form 990-T filers previously received the automatic six-month filing extensions, has not been revised.

Because of potential confusion caused by these discrepancies, the IRS is reviewing how to proceed on this issue. Pending clarification, Form 990-T filers who file Form 8868 in accordance with its instructions (including full remittance of the tax and signing the form) will be considered to have requested and obtained an extension of up to six months as requested on that form. A corporate Form 990-T filer who files Form 8868 without a signature will receive only a three-month filing extension and must file another Form 8868 if additional time is needed to file the 990-T return. An separate Form 8868 for other Form 990 series returns must be filed in addition to the Form 8868 for the 990-T, but can be filed without signature for the automatic three month extension